All posts tagged Borrowing Costs

We can’t take it any more! The clamor for more historical context on the current record low for U.S. interest rates has hit a fever pitch!

So we feel responsible to offer our loyal readers this excellent chart, concocted by the bond market savants over at Bianco Research in Chicago. It shows that with yields on the benchmark 10-year note hovering around 1.5%, we are indeed below the previous low mark for yields, etched way back in April 1946. As we write, the yield on the 10-year note is around 1.511%.

As die-hard market geeks know, back in the 1940s, the yield on the 10-year was effectively pegged by the Treasury Department in order to finance World War II. (Just check out the 2% flat-line on the chart during the war years of 1941-1945.) Those measures lasted until 1951, when the Fed again re-established independence.

But we couldn’t help but wonder why rates fell after the war. After all, weren’t people worried about the chance that the easy terms on which the war was financed would lead to an inflationary surge in prices? In fact, inflation was running at more that 10% in the post war period. So what gives? Why would people buy bonds at that point?

According to the great Sydney Homer’s “History of Interest Rates” the answer lies the the fact that there was a huge amount of pent up savings. Americans were flush with cash from working in the booming war industries. But they were forced to save much of their money because of price controls that were put in place during the war.

The result was a lot of savings that had to go somewhere. And much of it seemed to end up in bonds. And with memories of the bank failures of the early 1930s still fresh for many people, it’s likely some would have preferred the safety of U.S. securities to banks. (Although much of the Treasury bond issuance of the government was purchased by banks that were required to hold Treasurys as reserves.)

In fact, it was the apparently worries that the government would cut down its war-time borrowing and issue fewer bonds that set off the final scurry that sent interest rates to their record lows in 1946. After all, as long as the Treasury was pegging the rates, there was little risk of a rise in interest rates killing the price of the bonds.

Alright, enough of the 1940s memory trips. What’s the point, you say? The point is this, don’t underestimate how important the demand is for the direction of interest rates. In the late 1940s, the U.S. was staggering under a post-war debt level that eventually hit 109% of GDP. But it was able to finance that at extremely low cost because of pent up savings. Today, we’ve also got debt levels approaching historic levels and again rates are at record lows, because there’s an abundance of cash that’s not going into productive use, rather it’s rushing to the U.S. for safekeeping.

Although its worth noting, April 1946 marked the start of a bear market for bonds that lasted — with some fits and starts — until rates peaked in the early 1980s. Something to think about for those that have doubled down on bond buying in recent years.

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